In this case study of USD/YEN, I will show you how one could have used an extending fifth wave to prepare for a profitable trade. Let me start by asserting that the main goal of any trader is to identify low-risk trading opportunities before a move actually takes place. Once such a trading opportunity is identified, one should be patient for the right moment to pull the trigger. Elliott wave analysis offers one very clear trading set up that invariably produces impressive winners.

In your study of the Elliott Wave Principle, you would have read that in a five-wave sequence, one should normally expect one of the impulse wave to extend. If the first and third waves are of normal length, (andin my view a normal length is either equality, or the third wave being no more than 1.618 times the first), then we should look out for the fifth wave to experience an extension. For starters, one should continue to trade in the direction of the trend, ie. if we are in an up trend, we should continue to buy on every dip. Many traders will be selling their positions too early because all they notice is that we are in a fifth wave. A careful trader will know that in the present case, because we haven’t seen an extension so far, the fifth wave is likely to go farther than what most expect. So this smart trader (namely you) will gladly buy into dips! Those who short-sell in anticipation of a turn will soon get stopped, and when many stops get triggered, you will make even more money because the very action of stops being triggered is going to take your position deeper into the money.

But wait. The best is yet to come! You will probably wish to get out of your position in stages once the fifth wave travels a distance equal to the third wave. But the real icing on the cake is the knowledge that once the extended fifth wave has run its course, we will see a huge sell-off that will take the currency (or stock) straight back to about the 2nd wave of the extension. You can benefit not only from the knowledge of the speed of the move, but also from the extent of the move. (FX Option trades can be very profitable in such cases).

Let me illustrate this price action using an example from USD/YEN. Take a look at the following chart, and you will see how one could have positioned for a very nice move once you identified that the fifth wave was experiencing an extension.